Economists Finally See The Light!

With my new Ph.D. in Economics, in 1967, I quickly knew I was in the wrong discipline. My wife, a psychologist, helped me see that the basic assumptions economists made about human beings were ridiculous. As Nobel Laureate Daniel McFadden summarized them: “sovereign in tastes, steely-eyed and point-on in perception of risk, and relentless in maximization of happiness.” I also knew WHY economists assumed a world that did not exist. Without these assumptions, they could not build mathematical theorems about behavior. So the tail of math wagged the dog of reality. With my wife, I did some research applying psychology to economics, 41 years ago, in 1972, long before behavioral economics became fashionable (it was published only in 1978)* I also wrote a book on the subject, in 1982, but 31 years ago, no-one was interested. **

Today one can say that the mainstream of economics is behavioral. In a new paper by McFadden***, “he outlines a “new science of pleasure”, in which he argues that economics should draw much more heavily on fields such as psychology, neuroscience and anthropology. He wants economists to accept that evidence from other disciplines does not just explain those bits of behavior that do not fit the standard models. Rather, what economists consider anomalous is the norm. Homo economicus, not his fallible counterpart, is the oddity. “ (Source: The Economist, April 27, 2013).

Almost none of the models and assumptions of conventional economics hold water in the face of behavioral research. For example: in microeconomics, more choice is always better than (or at least as good as) less choice. As The Economist notes: “Economists tend to think that more choice is good. Yet people with many options sometimes fail to make any choice at all: think of workers who prefer their employers to put them by “default” into pension plans at preset contribution rates. Explicitly modeling the process of making a choice might prompt economists to take a more ambiguous view of an abundance of choices. It might also make them more skeptical of “revealed preference”, the idea that a person’s valuation of different options can be deduced from his actions. This is undoubtedly messier than standard economics. So is real life.”

And if conventional microeconomics, macroeconomics is completely out to lunch. Chief IMF economist Olivier Blanchard recently described macroeconomics as a “cat in a tree” – treed by the global financial crisis, unable to say decisively whether austerity (budget cutting) is good or bad or indifferent.

The behavioral revolution in economics came a bit too late. If it had come a decade earlier, if it had focused on key variables like trust and risk perception, perhaps economics could have helped forestall the global financial collapse in 2008, rather than contribute to it.